QUANTIFYING THE ROLE PLAYED BY SUNK CAPITAL COSTS IN REAL‐OPTIONS MODELS

Vivek Ghosal ()

Scottish Journal of Political Economy, 2010, vol. 57, issue 3, 343-358

Abstract: Sunk capital costs are essential in generating hysteresis in real‐options models that examine firms' decisions under uncertainty. The standard results show that greater uncertainty, in the presence of sunk capital costs, dampens firms' economic activity across a wide range of decision variables. In empirical examination of these models, there is a considerable lack of evidence on the conditioning effects of sunk capital costs. In this paper, I first detail alternative ways to use publicly available data to construct measures of sunk capital costs. The data reveal substantial differences across industries in their magnitudes of sunk capital costs. Second, I provide some evidence that the presence of higher sunk capital costs significantly exacerbates the effects of uncertainty.

Date: 2010
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